A commercial lease agreement is the binding contract that sets the rent, term, permitted use and obligations between a landlord and a business tenant. A well-drafted one names the parties, the premises, the rent, the lease term and the property use, and spells out fees, remedies, ancillary costs, rights and insurance.
When buying or renting a commercial property, you will sign several documents, chief among them the commercial lease agreement. The agreement legally compels concerned parties to fulfill certain obligations and protects their interests over the rented space.
Further, commercial lease agreements indicate the rights granted to tenants by the owners. Whereas verbal and written leases are legally binding, it is safer to use lease agreements considering the number of convoluted laws governing the landlord-tenant relationship. You want a document explicitly spelling out your wishes.
Ultimately, you should be in a position to understand what commercial lease agreements entail before signing one. Keep reading to find out what to include and expect in a commercial lease agreement.
What should a commercial lease agreement include?
A well-drafted commercial lease has five essential elements:
1. Parties of the Lease Agreement
You must note down the complete and correct names of the landlord and tenant. If you are signing on behalf of a business entity, indicate the company’s legal name to avoid liability if litigation arises.
2. The Premises
The lease must correctly identify the property. You must clarify the rentable and usable square feet area and write down the measured area.
3. The Rent
Renting commercial real estate may involve paying a base rent and additional monthly charges.
Therefore, the lease agreement must indicate how you will calculate the rent and the terms for paying the base rent.
4. The Lease Term
This is the period during which you will enforce the lease agreement. You have to note down the starting and closing date of the lease. In addition, you will address other details like due dates and bail-out options.
5. Property Usage
You must state the reasons for renting out a commercial property, including how the tenant will use the space. In short, the lease agreement should clearly define:
- The type of business conducted
- Products and services offered by the tenant
- Usage of the premises during the lease term
Failure to clearly define these elements may invalidate the lease, so address all these elements before signing a commercial lease agreement.
What should you look for before signing a commercial lease?
Before signing an agreement, there are standard clauses you must incorporate, including:
1. Hidden Fees
The most common fee you will notice in a lease is the rent. To detect any hidden charges, you will need to request a breakdown of the rent. With the help of a commercial real estate attorney, you can determine the fairness of the costs and negotiate accordingly.
2. Remedy Terms
Sometimes, unexpected events could lead to a breach or default. For instance, you may delay paying your rent, extend the lease period, or want to terminate your lease before the due date. Therefore, both parties need to agree on remedies for such eventualities.
3. Ancillary Terms
Apart from rent, there are other financial obligations that your lease agreement expects you to meet. These may include paying for repair and maintenance, security deposits, pass-throughs, rent hikes, and deductions on upgrades.
Pass-throughs are expenses that an owner should pay but chooses to transfer the burden to the tenant. If you do not scrutinize the fine print of these ancillary terms, you may get slapped with an unexpected bill.
4. Rights and Responsibilities
In lease agreements, there are clearly defined rights and responsibilities of the tenant and the landlord. They include restrictions, rules for using the leased space, and maintenance clauses.
Defying the laid down rules and restrictions may lead to hefty fines, arbitration, or litigation. It is crucial to read through them, seek clarity, and discuss them before signing the agreement with the lessor.
5. Insurance Clause
Renting commercial real estate has associated risks, such as canceled leases and business interruptions. The commercial lease agreements should specify the types of insurance taken out on the property.
Some of the insurance covers you need include leasehold insurance, rental interruptions insurance, and liability insurance. Ensure you capture this clause adequately in the agreement for clarity, so tag along an insurance broker to help negotiate with your landlord on the insurance terms.
How do you know if a commercial lease is a good deal?
As noted earlier, different leases will depend on the rent payment calculation. Before signing a commercial lease, analyze the rent and expected expenses.
There are tools, methods, and procedures you will use when gathering and organizing financial data for the analysis. To analyze the commercial lease agreement, you can use any of the following methods:
- Take note of your gross income, which is the amount a property generates before expenses.
- Determine the net operating income (NOI) the leased property generates, which is the revenue less operating expenses.
- Divide the amount of cash you spend over the amount you receive to determine your cash-on-cash return.
- Find out your cash flow by noting down the net amount you will retain after paying all expenses.
What makes a commercial lease invalid?
While commercial leases are legally binding, not all leases are valid. A void or invalid lease is an agreement that an interested party cannot enforce, which may happen if you ignore certain aspects of the contract. For instance, a commercial lease agreement is invalid if:
- You use the property to carry out illegal transactions
- A court of law deems one of the parties in the lease agreement as incompetent to sign a lease
- It is against a stipulated public policy such as not serving people of a certain ethnicity or religion
- One of the parties signed the lease under duress
- The lease is proven fraudulent
- The lessor is in illegal possession of the property
- It does not meet the requirements of a valid commercial lease agreement
- One of the parties breaches the contract
What are the types of commercial lease agreements?
Commercial lease agreements differ according to the rent calculation. There are four main types of lease agreements in commercial real estate:
1. Net Lease
This lease requires you to pay the rent and a portion of all fixed operating expenses. Net leases are either single, double, or triple.
2. Percentage Lease
You pay a base rent and a percentage from earned revenue.
3. Variable Lease
A variable lease agreement allows the tenant to pay a specified rent on a predetermined basis.
4. Gross Lease
Also known as the full-service lease, this lease has a fixed monthly payment. In this case, the landlord handles all other expenses. However, its base rent is relatively higher than the net lease.
Bottom Line
A lot goes into crafting a commercial lease agreement. Knowing what to look for in a commercial lease will help resolve issues and avoid arbitrary decisions from either party.
In case you are unsure of whether to sign up for a lease or not, you can seek help from appraisers, insurance agents, real estate agents, or legal experts. They will dissect the contract and help you decide whether it is favorable or not.
Frequently asked questions
Can you walk away from a commercial lease?
Only on the terms the lease itself allows. The lease term section should set the start and closing dates, the due dates and any bail-out options, and the remedy terms should say what happens if you want to end the lease before its due date. If those clauses are missing or vague, you have little to stand on. Read them, and have a commercial real estate attorney review them, before you sign.
What happens if you can’t pay rent on a commercial lease?
Late or missed rent is a breach or default under the lease. What follows depends on the remedy terms both parties agreed to before signing, which is why those terms belong in the contract from day one. Defying the lease’s rules and restrictions can also lead to hefty fines, arbitration or litigation. Negotiate the remedies up front, while you still have leverage.
What are the main types of commercial leases?
Commercial leases differ by how the rent is calculated. The four main types are the net lease (rent plus a portion of fixed operating expenses, in single, double or triple form), the percentage lease (base rent plus a percentage of earned revenue), the variable lease, and the gross or full-service lease, where one fixed monthly payment covers it, the landlord handles the other expenses, and the base rent runs higher.
Can you write your own commercial lease agreement?
Verbal and written leases are both legally binding, but landlord-tenant law is convoluted, so a written agreement that spells out exactly what each side wants is the safer choice. It must clearly name the parties, the premises, the rent, the lease term and the property use, or it may be invalid. Before signing, have appraisers, insurance agents, real estate agents or legal experts dissect it.
